Contingent Capital Instruments for Large Financial Institutions: A Review of the Literature

Posted: 25 Nov 2014

See all articles by Mark J. Flannery

Mark J. Flannery

University of Florida - Department of Finance, Insurance and Real Estate

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Date Written: December 2014

Abstract

As the recent financial crisis unfolded, a new financial instrument - contingent convertible (coco) bonds - was widely considered as a mechanism for promptly recapitalizing overlevered financial institutions. Essentially, the conversion feature of coco bonds would replace supervisory discretion about banks’ capital adequacy with rules specifying when new equity was required. Academics and regulators conjectured that including sufficient cocos in a bank’s capital structure could substantially insulate taxpayers from private investment losses. This potential fostered a literature evaluating the effect of cocos on bank and financial sector stability, risk-taking incentives, and corporate governance. I review this literature and suggest that regulatory capital definitions should be expanded to include substantial amounts of carefully designed coco bonds as a partial substitute for common equity in regulatory capital requirements.

Suggested Citation

Flannery, Mark Jeffrey, Contingent Capital Instruments for Large Financial Institutions: A Review of the Literature (December 2014). Annual Review of Financial Economics, Vol. 6, pp. 225-240, 2014. Available at SSRN: https://ssrn.com/abstract=2530446 or http://dx.doi.org/10.1146/annurev-financial-110613-034331

Mark Jeffrey Flannery (Contact Author)

University of Florida - Department of Finance, Insurance and Real Estate ( email )

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